Warren Buffett's investing advice for the rest of us

Wednesday

Feb 26, 2014 at 6:00 AM

By Peter S. Cohan WALL & MAIN

Fortune published an excerpt from investment legend Warren Buffett's latest annual letter. And it offers a simple piece of advice for people like me who are not good at estimating how much a company should be worth. It's advice I have offered investors in this column — invest in a low expense S&P 500 index fund, instead of individual stocks or funds managed by expensive advisors.

While Mr. Buffett — whom Forbes estimates has a net worth of $58.5 billion — needs no introduction, it is worth examining how well his investment decisions have fared over the years. For instance, if you had invested $7,175 in a share of Berkshire Hathaway Class A in May 1990, it would be worth $170,540 today — a 2,279 percent increase. If you had purchase the same amount of an S&P 500 index fund back then, it would be worth 408 percent more — or a relatively paltry $29,274.

Sadly, Mr. Buffett shares some characteristics with the rest of humanity, in that he is mortal. And that means that if you chose to had enough cash lying around to purchase shares of Berkshire Hathaway, there is no assurance that they would keep going up as much as they have in the past once Mr. Buffett shuffles off this mortal coil.

His latest shareholder letter does provide some useful investment advice that in my opinion is worth far more than the nothing that you pay to read it. To illustrate that advice, Mr. Buffett gives two examples of investments that he made, neither of which are publicly-traded companies. In both cases, Mr. Buffett's advice is clear: Buy solid businesses at a very low price due that is available because the sellers are desperate to sell; know very concretely why the business will be worth more in the future; and make sure you are partnering with someone who knows how to operate the business to deliver on that promise of future value.

While it's worth delving into the two examples Mr. Buffett provided, it is also worth pointing out that the average investor hardly ever comes across such opportunities these days. The first example was the $280,000 Mr. Buffett paid the FDIC in 1986 for a 400-acre farm located 50 miles north of Omaha. The second was "a small investment" he made in 1993 in a retail property near New York University that the Resolution Trust Corp. was selling and that he became aware of because his landlord when he was Chairman of Salomon Brothers was also the landlord for that retail property.

In both cases, Mr. Buffett was buying from a government agency that had taken over the asset in the wake of a financial bubble bursting. And that government agency was in a hurry to sell the asset to get it off the government's books. So Mr. Buffett was able to buy the asset at a low price. In both cases, Mr. Buffett had no expertise in managing the asset but was able to partner with an expert operator.

And in both cases, he felt confident that the value of the asset would appreciate. In the case of the retail property, a major tenant had secured a way-below-market rental rate and when the lease expired, the rate would rise to be at least equal to the prevailing market rate.

Unless all three conditions are satisfied in a specific investment opportunity, Mr. Buffett chooses not to invest. It seems clear to me that Mr. Buffett has achieved a level of success that makes it possible for him to get access to investment opportunities that the rest of us cannot.

A recent example that comes to mind is the $5 billion preferred stock investment that Mr. Buffett made in Goldman Sachs in the middle of the financial crisis in September 2008. He was able to negotiate a very attractive 10 percent fixed rate payment plus an option to buy shares in Goldman Sachs at $115 a share. After the deal was announced, Goldman shares traded at $125 and they are now at $166 — making that option highly profitable. Goldman Sachs clearly was willing to pay dearly for Mr. Buffett's imprimatur at that shaky time in its history.

But for the rest of us, these investment opportunities are few and far between. The good news is that Mr. Buffett does not force us to buy his shares to get access to his investment expertise. He suggests that we should do what he advises his trustee to do with his cash.

As Mr. Buffett wrote, "My advice to the trustee could not be more simple: Put 10 percent of the cash in short-term government bonds and 90 percent in a very low-cost S&P 500 index fund. (I suggest Vanguard's (VFINX). I believe the trust's long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions, or individuals — who employ high-fee managers."

In short, you can't beat the market — nor can most professional investors — so just keep up with the market and don't pay fees to people who claim they can beat it but can't.

Peter Cohan of Marlboro heads a management consulting and venture capital firm, and teaches business strategy and entrepreneurship at Babson College. His email address is peter@petercohan.com.